Purpose The purpose of this paper is to examine whether analysts’ cash flow forecasts improve the profitability of their stock recommendations and whether the positive effect of cash flow forecasts on analysts’ stock recommendation performance varies with firms’ earnings quality. Design/methodology/approach To test the authors’ predictions, they identify a sample of 161,673 stock recommendations with contemporaneous earnings forecasts and/or cash flow forecasts and regress market-adjusted stock returns on a binary variable that proxies for the issuance of cash flow forecasts while controlling for contemporaneous earnings forecast accuracy, earnings quality, analysts’ forecast experience and capability and certain firm characteristics. The authors’ test results are robust to alternative measures of recommendation profitability, earnings quality and the use of recommendation revisions instead of recommendation levels. Findings The authors find that when analysts issue cash flow forecasts concurrently with earnings forecasts, their stock recommendations lead to higher profitability than when they only issue earnings forecasts, after controlling for analysts’ forecast capability. Moreover, the authors document that the contemporaneous positive relationship between cash flow forecasts and recommendations profitability is stronger for firms with low earnings quality than for firms with high earnings quality. The findings suggest that cash flow forecasts issued by analysts in response to market demand likely play a more important role in firm valuation than cash flow forecasts issued by analysts mainly because of supply-side considerations. Research limitations/implications Future research could build on these findings to conduct further investigation on the alternative incentives for analysts’ forecasts of sales growth and long-term growth rates. Practical implications These findings may also help investors to better assess the quality of analysts’ research outputs and to identify superior stock recommendations. Originality/value This study provides insight into the role of cash flow forecasts in firm valuation and adds fresh evidence to the debate on the usefulness of cash flow forecasts. It extends the stream of research on the characteristics of analyst forecasts and increases our knowledge about the role of analysts in the financial market.
As globalization increases and companies expand their foreign operations, their reported results, such as earnings per share, are increasingly affected by the volatility of daily foreign currency exchange (FX) rate fluctuations. The case provides a series of requirements to alert students to the effect that FX rate fluctuations have on reported operating results of a hypothetical company whose accounting records are kept in multiple currencies. The hypothetical company is based on a composite of four comparable real companies. Subsidiaries are located in the Euro Zone and China to highlight the difference between a floating currency experiencing volatility and a managed currency. These currencies allow students to address the uncertainties of sovereign debt crises and changing currency policies by governments. Students research applicable standards, obtain disclosures from Form 10-Ks, obtain FX rates, complete Excel worksheets to translate monthly income into U.S. dollars, observe how reported net income changes with the pattern of monthly income and FX rates, discuss the usefulness of the mandatory disclosure on foreign exchange exposure, address the risk factors affecting future FX rates, compute debt covenant requirements, and assess how the variations of FX rates affect the company's compliance with these debt covenants and its ability to implement its business strategy.
Purpose Audit firm diversification can take many forms. Strategic management theory suggests that if the diversification has a narrow focus, it can have a positive effect on performance through knowledge spillover. However, if the diversification is too wide, the lack of economies of scope may cause an even negative impact on performance. The purpose of this paper is to examine the effect of an audit firm’s diversification strategy on audit quality. Design/methodology/approach Specifically, the authors test whether auditors can benefit from knowledge spillover in their area of specialization. Findings The authors find that the magnitude of discretionary accruals and the balance of below-the-line item are significant lower for clients from narrowly diversified area than those from a widely diversified area, suggesting a higher audit quality due to possible knowledge spillover. In addition, the authors find such benefits are more pronounced with clients with high earnings volatility. Originality/value This study extends the studies on auditor industry specialization by examining the effect of audit firms’ diversification on audit quality and assessing potential differences on audit quality between narrow and wide diversification.
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